Borrowing money from family and friends

Sema Fongod, of link, reveals a step-by-step guide to borrowing from loved ones without having to jeopardise any personal relationships.

Borrowing cash from friends and familyA major impediment often faced by small business owners is a lack of capital, and overcoming this obstacle can prove to be difficult. Standard criteria for bank lending are getting more and more stringent and start-ups hardly have the security independent lenders seek when they’re dispensing loans.

Though widely considered as a last resort when seeking funding, borrowing money from family and friends still remains a suitable funding option for SMEs, given the limited capital and credit available.

It’s commendable to approach friends and family in the same way you would approach a formal lender. This is a common mistake made by business owners which often results in jeopardised personal relationships and sometimes business failure. Here are a few tips on how to increase your odds for a successful investment from a loved one:

  • Prepare a business case – Specify how long you need the money for and reveal to them how their funds will be used to grow your business. Show them a convincing case for investing in your business, just as you would show the bank.

  • Present your business plan – Prior to the meeting, you should create a concise business plan that demonstrates your plans for the business and how their investment fits in.

  • Document the business agreement – No matter what terms you work out, it is vital to put them in writing. Spell out any return to investment they will receive, the amount borrowed and the required payment terms. Both parties must comprehend the loan terms and repayment arrangements before signing the paperwork.

Before approaching a friend or family member for capital, it’s important to ensure that they have the financial means to make a worthwhile contribution. Usually, if the loan amount is in excess of £100k, consult an accountant or attorney to help with the bookkeeping and tax services.

In addition, clarify whether the family member or friend will have any financial liabilities for your business management. Pass on the reasons why you were turned down by the bank or other lenders. Make them aware of all the risks and worst-case scenarios.

Borrowing money from family and friends can be a perfect solution, but be sure to look at the pros and cons of this approach.

The Pros… Benefits of borrowing from loved ones

  • Flexible Terms: Unlike other forms of traditional finance, funding from family and friends is typically offered on flexible terms. Friends and family may agree to a longer repayment period and may seek a lower rate of return than traditional lenders. On a practical level, little or no security is required and the repayment can be tailored to your financial projections.

  • Minimal charges: One of the greatest advantages of borrowing money from friends and family is that the funds are offered at little or no interest. As a start-up or loss-making company, the interest rate charged by traditional lenders can be very high.

  • Easy to set-up: On a personal level, the family member or friend already knows your ethos and business circumstance and so are less likely to demand a detailed business plan.

The Cons… Disadvantages of borrowing from family & friends

  • Family feuds and friendship squabbles: One potential downside of borrowing from friends and family is that slow or non-payment can fracture relationships on a personal level. Losing the friendship and support of loved ones should mean much more to you than the initial sum borrowed in the first place.

  • Who’s in control? There is a real risk when borrowing from family members; the individuals may feel that they are now part-owners of the company, with a right to make business decisions. You can avoid this by stating in the loan terms that you will be in charge of the day-to-day operations of the business.

  • Less stability: Family and friends can sometimes demand quicker repayment prior to the arranged terms (due to personal financial issues), whereas bank and other independent lenders have more stability.

Borrowing money from loved ones is a suitable funding solution for small businesses, especially start-up companies. This is because banks will be wary of lending to businesses with no evidence of successful trading. However, there are several banks and independent lenders that offer other facilities to small firms looking to expand and improve their cashflow. This includes factoring and invoice discounting services, tailored to businesses with cash tied up in outstanding invoices.

For further information on subjects raised in this guide you might like to have a look at our small business advice articles on Writing a Business Plan and Cashflow Management.

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